Buoyancy shown in local commercial property finance

While the local commercial property finance market has been constrained by poor GDP growth, rising operating costs and low business confidence in the first half of 2015, it remains remarkably buoyant, continuing the strong trend seen over the last few years.

According to Robin Lockhart-Ross, Managing Executive of Property Finance at Nedbank Corporate and Investment Banking, a notable trend for Property Finance since the Global Financial Crisis in 2008 has been the improvement in the quality of its book. “Four or five years ago, 3.5% of our total commercial property finance book was problematic – that number is now less than 1.25%. This is a low ratio by bank standards, where anything below 2% is acceptable. Our credit loss ratio (bad debt as a function of the total book), which is usually between 0.2%-0.4%, is currently less than 0.2%”. He notes that most competitors are experiencing similar trends.

Property Finance at NCIB has consistently performed in recent years, attracting the largest market share of the commercial property finance market in South Africa at 34%. “Our book reached R100bn in middle of 2014 and then R110bn by the end of 2014 and now stands at an estimated R119 billion as at end August 2015, a significant achievement given the current economic environment.”

He notes however, that there are some headwinds facing the commercial property finance market. “The upcoming implementation of Basel III capital and liquidity requirements is set to present some challenges that will make it increasingly difficult and costly for banks to lend on a longer term basis.”

These requirements mean that the amount of capital banks need to hold against a loan increases as the term of the loan itself increases. In addition, new liquidity ratios are going to be applied in 2018 that will require banks to source funding for its loan book of duration that matches the period of the loans, which will be difficult to achieve in the SA market. This is likely to see banks having to shorten the period of their loans to property investors, which in turn may also result in non-bank lenders increasing their presence in the property finance market as they will not be subject to the same strict requirements under Basel III regulations.

In taking a view on the anticipated performance of the property market in 2015 and beyond, Lockhart-Ross notes the following:

Listed property
The listed property sector has seen a high level of activity, with most of the big players looking to increase the size of their portfolios. “For example, Growthpoint recently acquired Acucap Properties and Sycom Property Fund, while Redefine took a 66% stake in Fountainhead and acquired the unlisted Leaf Properties portfolio. Finding quality stock at realistic values is difficult, which has seen bigger funds acquire and consolidate smaller funds.”

He adds that as listed property funds in South Africa are well managed, well diversified and well hedged, they represent the safest prospect from both an investor’s and a lender’s perspective, despite the market having entered a rising interest rate cycle.

Office market
According to Lockhart-Ross, the office market remains the most concerning for bankers, particularly in certain locations where there is existing or looming oversupply. “For example, A Grade office space in Sandton has vacancy levels of above 11%. While development and refurbishment has continued, most of these projects are tenant driven.

He says that banks are cautious about funding new office developments unless they are supported by a strong tenant on a long lease, or they are being undertaken by a listed fund or substantial developer with a strong balance sheet. Another contributing factor to the concern surrounding the office market is the consolidation of offices by the big corporates in mega head office campuses in key nodes, with the subsequent negative impact this has of increasing the level of vacant space in surrounding or secondary nodes.

Industrial market
Lockhart-Ross says that the industrial property market has seen positive growth over the last few years, with one of the main reasons being the drive for efficiency and scale in logistics and distribution amongst retailers. “Three or four years ago a 50 000m² warehouse was considered substantial, now, many of these facilities are over 100 000m². The market has also been fuelled by other balance sheet transactions, such as the recent sale and leaseback deals by major industrialists like Macsteel and Aveng looking to refinance their owner-occupied property portfolios .”

He adds that while there has been substantial development activity in the Waterfall node around the Mall of Africa that is currently under construction by Attacq, overall there is not a significant amount of new building development taking place in the industrial sector and only a few new industrial nodes being developed like Cornubia to the north of and Hammarsdale to the west of Durban.

“Although a number of major shopping centres have recently come, or are coming on stream, such as Newtown Junction in Johannesburg CBD, Forest Hill in Centurion, Bay West in Port Elizabeth and Mall of Africa in Midrand– the reality is that very few opportunities for mega retail projects remain. In the major cities, there are potential opportunities for new regional malls in Kempton Park near OR Tambo airport in Gauteng and in the Table View/ Blouberg area in the Cape, but most secondary cities already have their regional malls. Though townships and rural areas are still experiencing development and refurbishment activity by established players, caution needs to be exercised by developers and bankers to understand the reasons and dynamics that are driving retail demand in these areas, which is mostly based on supporting infrastructure as well as government subsidies and grants.”

He adds that selective opportunities still remain in niche retail centres, many of which exist nearby to and are complementary to regional malls; as well as in township and rural areas, provided these are underpinned by real economic growth and solid retail fundamentals.

Residential market
According to Lockhart-Ross, the residential sector is encouraging. “We are witnessing several substantial new high-rise sectional-title residential developments in areas like Sandton and Rosebank, driven by proximity to work, ease of interaction and the expanded Gautrain routes. And in KwaZulu Natal, the last phase of Pearls of Umhlanga achieved just north of R1 billion in pre-sales, while it is estimated that a significant number of new residential units are planned and proposed over the next few years for the Atlantic Sea Board in Cape Town.

“In addition there is an emerging trend whereby listed property funds such as Arrowhead, SA Corporate and Redefine are acquiring and developing residential properties within their existing portfolios. Previously only a few listed funds like Premium and Octodec included any meaningful residential components. This trend is not surprising as occupancy levels in residential properties in key nodes are good, while defaults and arrears are low. So it’s quite possible that we will see the formation of a dedicated residential REIT in the market in the near future.”

He adds that the development of student accommodation is also attracting more entrants and gaining more traction especially in traditional university towns, with the likelihood of a student accommodation fund coming to market soon.

“While we believe that the market for residential developments should stay strong until at least 2017/18, it is important to remember the lessons learnt post the global financial crisis from undertaking and funding mega lifestyle developments in multiple phases over extended periods. “We saw then the challenges that can arise should the economy change, so it remains critical to consider the financial substance and track record of the developers and the period and phasing of the development to ensure any possible risk is managed.”